Invesco Global Sovereign Asset Management Study 2020

 
Invesco Global Sovereign Asset Management Study 2020
Invesco Global
Sovereign Asset
Management Study
2020
  Invesco Sovereign Asset Management Study 2020   i
Invesco Global Sovereign Asset Management Study 2020
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ii        Welcome
Invesco Global Sovereign Asset Management Study 2020
Home

Welcome                                                 02

Key metrics                                             04

Theme 1                                                 08       Theme 4                                                40
Sovereigns look through the crisis for opportunities             Central banks: testing resolve in risk assets

For sovereigns with dry powder, the market collapse in           Covid-19 prompted a flight to US dollar perceived
early 2020 was an unprecedented buying opportunity.              safety and liquidity, reversing a long-term gradual
Most are well positioned to allocate capital due to              trend towards currency diversification and away
end-of-cycle caution and longer-term investment                  from the USD, due to heightened concerns over
time horizons. For some, including commodity-based               political and economic risks. Despite a difficult
sovereigns, valuable lessons learned from the financial          market environment, central banks continue to
crisis left them with more robust portfolios that could          be committed to long-term strategic plans for
contend with government withdrawals without major                diversification and greater exposure to risk assets.
allocation adjustments or forced asset sales.

Theme 2                                                 18       Theme 5                                                54
A battle for talent on two fronts                                Rising of climate change:
                                                                 commitment and opportunity
Sovereigns and central banks have recognised gaps
in capabilities where talent is scarce and heavily               Once seen as a distant consideration, concerns about
competed for. For sovereigns, internalising private              the immediate impact of climate change are now a
market expertise is especially tough, while central              real focus for sovereigns and central banks. Investors
banks struggle with ESG (Environmental, Social and               are committing to carbon reduction targets, increasing
Governance) and fund manager selection. Internal                 utilisation of climate modelling and investing in thematic
development and retention programmes designed                    opportunities, particularly in clean technology. However,
to meet the challenge have delivered mixed results;              an absence of coordinated regulatory action hampers
a significant minority intend to engage additional               efforts with inconsistent taxonomies, definitions and
external support.                                                regulations seen as obstacles to greater adoption.

Theme 3                                                 32       Appendix                                               66
Gold: a glimmer of hope amid market turmoil

Market volatility and increasing government debt
levels have bolstered the case for gold in institutional
portfolios. Sovereigns view gold favourably as a
potential hedge against inflation and portfolio tail-risks.
While gold is a more established asset class in central
bank portfolios, interest has also increased due to its
low correlation to other central bank assets and, more
recently, a growing appreciation for its usefulness as
a liquid replacement for negative yielding debt.

                                                              Invesco Sovereign Asset Management Study 2020              iii
Invesco Global Sovereign Asset Management Study 2020
Welcome
                           Welcome to Invesco’s                The five themes in the report look
                           eighth annual study                 to both build on the work of previous
                                                               years, and highlight new trends
                           of sovereign investors.             and themes that have emerged
                           Since the publication of            over the past year. Fieldwork was
                           the first report in 2013,           carried out in the first quarter of
                                                               2020 as the implications of the
                           the study has evolved to            Covid-19 pandemic were unfolding.
                           cover 139 institutions,             Consequently, the response to the
                           including interviews with           immediate shock and dramatic
                                                               market movements dominated the
                           chief investment officers,          focus for many respondents.
Terry Pan                  portfolio strategists and
Chief Executive Officer,   heads of asset classes at           Many were well prepared however,
Greater China, South       83 sovereign funds, and             with a drop in valuations and plenty of
East Asia and Korea                                            dry powder making the crisis a good
                           56 central banks. Together,         buying opportunity, as discussed in
terry.pan@invesco.com      these investors represent           Theme 1. Infrastructure was a focus
                           US $19 trillion (as of              for some, especially in electricity
                                                               generation and communications.
                           March 2020).

                           Theme 1                             Theme 2

                           “We had a lot of dry               “We are successful at
                             powder ready for the end            recruiting talented entry-
                             of the cycle; there appeared        level staff. However, at a
                             to be so many opportunities         more senior level the market
                             it was difficult to act             for local talent is thinner
                             fast enough.”                       and we are then competing
                                                                 worldwide against similar
                                                                 organisations.”

                                  Investment sovereign, EMEA                Liability sovereign, APAC
a
Invesco Global Sovereign Asset Management Study 2020
Theme 2 explores People and Talent,       Central bank portfolios have changed     decarbonisation is top of the list,
a theme we examined in 2015. As           significantly since the last crisis of   while investors in Asia and the Middle
some funds look to internalise specific   2007-2008. Theme 4 finds many            East are especially preoccupied
investment capabilities, significant      bankers responding to the crisis by      with mitigating the direct effects of
gaps are beginning to appear between      seeking safety and liquidity in the      extreme weather on the portfolio.
existing and required capability. ESG     US$, reversing the trend towards         Carbon modelling, direct investment
poses a particular challenge, as do       currency diversification seen over       and climate targets are emerging
the challenges of investing in certain    the past few years. In contrast to the   as central strategies for dealing
markets, especially those in Asia.        last crisis, however, many central       with climate change, yet a lack of
                                          bankers remain committed to risk         a single taxonomy makes unified
The market turmoil generated in the       assets and expect to continue with       action difficult.
wake of Covid-19 cast significant light   diversified strategic allocations.
on gold. The 2019 report highlighted      ETFs have taken on a greater role in     We hope this report gives you an
the increasing attractiveness of          diversification strategies, especially   interesting and informative insight
gold to central banks, while this         at a time when banks are looking to      into the world of sovereign investors.
year’s report looks more closely at       build investment capability.             If you would like to discuss these
the asset class. Both sovereign and                                                findings or have any questions,
central bank investors are considering    In our fifth theme we return to          please do get in touch. For more
increasing allocations, suggesting a      the ongoing focus on ESG, this           content on this year’s themes,
resurgence in popularity in the face      time honing in on institutional          please visit igsams.invesco.com.
of significant burgeoning government      efforts to mitigate the effects
debt levels, and fears of a potential     of climate change. For investors
return of inflation.                      in North America and Europe,

Theme 3                                   Theme 4                                  Theme 5

“Physical gold doesn’t                   “We think we can                        “Even with a global
  answer our needs in terms                 reduce portfolio risk by                 pandemic, addressing
 of liquidity and making                   introducing a small equity                climate change remains a
 sure our government can                    allocation; we are trying                priority. Rising greenhouse
 meet its obligations at all                to take a long-term view                 gas emissions are the most
 times, as transaction costs                and not worry about                      dangerous threat to our
 are higher for physical                    short-term fluctuations.”                planet and portfolio.”
 assets. Therefore we might
 consider using ETFs.”

        Central bank, Latin American                        Central bank, EMEA Investment sovereign, North America
                                                           Invesco Sovereign Asset Management Study 2020         b
Invesco Global Sovereign Asset Management Study 2020
Key metrics
Time horizons
                                         Figure A
Investment time horizons among           Time horizon of investment objectives (years)
sovereign investors have continued
to extend over the past year, rising
to 9.4 years from 8.5 years in                                               2017         2018          2019             2020
last year’s study. This has been
driven by investment and liability
sovereigns and corresponds with             Total ex central bank
rising allocations to illiquid, long-                                                 7.4
dated assets in private markets. Time
                                                                                          7.8
horizons for liquidity and development
sovereigns have held steady at 3.0                                                              8.5
years and 6.8 years respectively.
                                                                                                      9.4

                                            Investment
                                                                                    6.9
                                                                                    6.8
                                                                                            8.1
                                                                                                            9.9

                                            Liability
                                                                                                      9.2
                                                                                                      9.2
                                                                                                             10.5
                                                                                                                  11.0

                                            Liquidity
                                                                3.2
                                                                       3.9
                                                              3.0
                                                              3.0

                                            Development
                                                                                          7.7
                                                                                            8.1
                                                                                    6.8
                                                                                    6.8

                                         What is the time horizon of                            Sample size: 2017 = 57, 2018 = 64
                                         your investment objective?                                          2019 = 65, 2020 = 58

4         Key metrics
Invesco Global Sovereign Asset Management Study 2020
Performance
                                          Figure B
In contrast to the difficult conditions   One-year actual returns (%)
brought about by Covid-19 in 2020,
2019 proved to be a positive year
for performance. Sovereign investors                                               2016          2017        2018           2019
achieved an average return of 7.6%
thanks to strong equity markets and
rising bond prices. This was almost          Total ex central bank
twice the average 2018 sovereign                                     4.1%
return of 4% that was highlighted in
                                                                                                          9.4%
our 2018 Study.
                                                                    4.0%
Liability sovereigns performed best
                                                                                                7.6%
in 2019 with returns of 8.3%, thanks
in part to their greater exposure to
listed markets, which also helped            Investment
investment sovereigns (returns of                         2.7%
8.0%) and liquidity sovereigns (returns
                                                                                                             10.2%
of 6.1%). With their greater emphasis
on private over listed markets,                                                   5.8%
development sovereigns delivered
slightly more muted performance.                                                                 8.0%

                                             Liability
                                                                            5.0%
                                                                                                          9.2%
                                                               3.4%
                                                                                                   8.3%

                                             Liquidity
                                                           2.8%
                                                                                         6.6%
                                                      2.2%
                                                                                    6.1%

                                             Development
                                                                         4.6%
                                                                                                                         11.8%
                                                                                        6.3%
                                                                                  5.8%

                                          What has been your fund’s actual percentage                            Sample size: 2016 = 49
                                          annualised return (at 31 December 2018)                                 2017 = 52, 2018 = 55
                                          over the past one year period? (%)                                                  2019 = 71

                                                             Invesco Sovereign Asset Management Study 2020                                5
Invesco Global Sovereign Asset Management Study 2020
Asset allocation
                                       Figure C
Allocations to fixed income            Asset allocation trends (% AUM)
increased in 2020, to stand at 34%.
Meanwhile, allocations to equities
fell from 30% to 26% due in part                                           2014          2015          2016           2017
to end-of-cycle concerns that led                                          2018          2019          2020
to decreasing strategic allocations.
Sovereign investors now have
an average of 24% allocated to
alternative investments (excluding                  9%        9%                          4%                   4%
direct strategic investments) with                                             7%
                                                                      5%                             5%
allocations continuing a five-
year-long upward march. Within                                                Cash
alternative allocations, private
equity and real estate continue to
be the largest sub-sectors, although               33%        33%                                   33%       34%
infrastructure and hedge funds /                                     29%       29%       30%
absolute return funds registered
the largest year-on-year increases.

                                                                           Fixed income

                                                                     33%                 33%
                                                   29%        29%              29%                  30%
                                                                                                              26%

                                                                              Equity

                                                                                                              20%
                                                                               17%       17%        18%
                                                                     13%
                                                    9%        9%

                                                                      Illiquid alternatives

                                                    3%                3%                  3%         3%        4%
                                                              2%               2%

                                                                      Liquid alternatives

                                                   17%        18%    17%       16%
                                                                                         13%                  12%
                                                                                                    11%

                                                               Direct strategic investments (DSI)

                                       What is your current                          Sample size: 2014 = 48, 2015 = 44, 2016 = 57
                                       asset allocation?                              2017 = 62, 2018 = 63, 2019 = 53, 2020 = 78

6         Key metrics
Invesco Global Sovereign Asset Management Study 2020
Figure D
Alternative investment asset allocation trends (% AUM)

                                     2014          2015           2016          2017
                                     2018          2019           2020

                                                             6.9%       7.1%
                                        6.5%       6.4%

                              4.5%
            3.6%
                       3.0%

                                 Private equity

                                                                        9.0%
                                                             8.7%
                                        8.1%
                                                   7.7%

                              6.5%

            4.3%       4.1%

                                     Real estate

                                                                        3.6%
                                                   3.2%
                              2.8%                           2.7%
                       2.1%             2.1%
            1.5%

                                 Infrastructure

                                                                        3.1%

                              2.0%                 2.0%      2.1%
            1.6%       1.5%             1.6%

                       Hedge funds / absolute return funds

                       0.5%   0.6%                 0.6%
            0.9%                        0.3%                 1.0%       1.0%
                                  Commodities

What is your current                           Sample size: 2014 = 48, 2015 = 44, 2016 = 57
asset allocation?                               2017 = 62, 2018 = 63, 2019 = 53, 2020 = 78

                                                                    Invesco Sovereign Asset Management Study 2020   7
Invesco Global Sovereign Asset Management Study 2020
Theme 1

Sovereigns
look through
crisis for
opportunities
For those sovereigns with dry powder,
  the market collapse in early 2020 was
  an unprecedented buying opportunity.
 As custodians of long-term capital, most
also benefit from the lack of an imperative
        to sell to meet withdrawals.
                                                                          Fixed
                                                                         Income
                                                            Equity

                                                     Even before Covid-19 wreaked havoc
                                                    on markets, sovereigns’ average equity
                                                 allocations at the end of 2019 were at their
                                                  lowest level since 2013. Over the next 12
                                                months, sovereigns plan to continue allocating
                                                 to fixed income – particularly alternatives –
                                                     and illiquid assets in private markets.

 In infrastructure, sovereigns are targeting
  electricity generation and transmission,
  and communications sectors. Electricity
projects that help countries transition away
     from fossil fuels are seen as a way
         of meeting ESG objectives.

                                                  Some commodity-based sovereigns are
                                               braced for calls on capital from governments.
                                                  However, most have large cash reserves
                                                   and should be in a strong position to
                                                  accommodate this without major asset
                                               allocation adjustments or forced asset sales.
Sovereigns with dry powder               Figure 1.1
reported being presented                 Annual returns (average %, sovereigns)
with unparalleled buying
opportunities as the                                                                   9.4%
Covid-19 pandemic caused
asset prices to plummet.                                                                                                7.6%

Indeed, a number interviewed in this
year’s study are already benefitting               4.2%              4.1%
from strict rebalancing rules that                                                                      4.0%
necessitate purchases when
allocations fall below set thresholds.

The pandemic has created                          2015              2016              2017             2018             2019
opportunities for those able to
move quickly, as one EMEA-based          What has been your fund’s percentage annualised return         Sample size: 2015 = 49, 2016 = 49
sovereign explained: “We had a lot       (at 31 December 2019) over the past one year?                   2017 = 52, 2018 = 55, 2019 = 71
of dry powder ready for the end of
the cycle; there appeared to be so
many opportunities it was difficult to
act fast enough. Our internal team       Figure 1.2
had trigger mechanisms in place to       Performance against targets in 2019 (% citations, sovereigns)
snap up AAA-rated bonds when they
hit certain prices, and these have
already seen gains as bond prices
have recovered from their lows.”

Having the courage, conviction and
mandate to buy into market routs
can have a significant impact on
long-term performance. Many of
the best-performing sovereigns of                                                                 66% 10%                    24%
the past ten years are those that                                                      Outperform         Meet Underperform
ploughed into equity markets after
the global financial crisis (GFC) of     Did you outperform, meet or underperform your target return in 2019?             Sample size: 59
2008. As custodians of long-term
capital, sovereigns were keen to
stress that they can move with
certainty and confidence into market
weakness, with many benefitting not
only from their longer-term objectives
but from the lack of an imperative
to sell to meet withdrawals.

In 2019, sovereigns registered their
second highest average performance
of the previous five years, with two-
thirds outperforming their targets
(Figures 1.1 and 1.2). However,
even before the Covid-19 outbreak,
late-cycle fears meant that most
respondents were cautious. As a
result, average equity allocations at
the end of 2019 had been cut to
their lowest levels since 2013, down
by 7 percentage points compared to                              As one EMEA-based sovereign explained: “We had a
                                                                lot of dry powder ready for the end of the cycle; there
                                                                appeared to be so many opportunities it was difficult
                                                                to act fast enough. Our internal team had trigger
                                                                mechanisms in place to snap up AAA-rated bonds when
                                                                they hit certain prices, and these have already seen
                                                                gains as bond prices have recovered from their lows.”

10        Theme 1
Figure 1.3
Asset allocation by year (average %, sovereigns)

                       Cash      Fixed income        Equity     Illiquid alternatives       Liquid alternatives             DSI

   2013
         7%                                        35%                         26%       7% 3%
                                                                                            3%                            22%

   2014
            9%                                     33%                             29%          9% 3%
                                                                                                   3%                     17%

   2015
            9%                                     33%                             29%          9%2%2%                    18%

   2016
      5%                               29%                                   33%              13% 3%
                                                                                                  3%                      17%

   2017
         7%                              29%                              29%                    17%2%2%                  16%

   2018
    4%                                 30%                                   33%                        3%
                                                                                                    17% 3%                13%

   2019
      5%                                     33%                               30%                        3%
                                                                                                      18% 3%              11%

   2020
    4%                                       34%                         26%                        20% 4%                12%

What is the current allocation                                               Sample size: 2013 = 33, 2014 = 48, 2015 = 44, 2016 = 57
for the following assets?                                                                 2017 = 62, 2018 = 63, 2019 = 53, 2020 = 78

                                          the same time two years ago. Over             lower prices, spring’s market rebound
                                          the same period there had been an             has done little to curtail the overall
                                          increase in fixed income allocations,         trend to lower equity allocations at
                                          up by 4 percentage points, and illiquid       the time interviews were conducted.
                                          alternatives up by 3 percentage points        As one North American liability
                                          (Figure 1.3).                                 sovereign explained: “We thought
                                                                                        equity prices looked stretched before
                                          Despite dramatic revaluations                 the pandemic, given the stage of the
                                          across numerous asset classes, that           cycle, and even now they are not
                                          caution remains. While several noted          that far from all-time highs, despite
                                          that there had been opportunities             a global economic shutdown and a
                                          to purchase quality companies at              massive surge in unemployment.”

                                                              Invesco Sovereign Asset Management Study 2020                        11
Fixed income and illiquid alternatives retain their appeal
Overall, 43% of sovereigns are planning to increase allocations to fixed
income over the next year (with 24% decreasing) while only 22% plan to
increase equity allocations (compared to 37% decreasing). At the same time,
illiquid alternatives continue to attract inflows, with 43% planning to increase
allocations to both private equity (PE) and infrastructure, and 38% planning
to increase allocations to real estate (Figure 1.4).

However, government interventions, including rate cuts and a new round
of global quantitative easing, forced down yields and had a positive impact
on many fixed income portfolios. This has been aided by a significant rally
in riskier parts of the fixed income market, including high-yield bonds and
leveraged loans, which had initially seen some of the sharpest selloffs.

  Figure 1.4
  Asset allocation intentions for next 12 months (% citations, sovereigns)

                       Decreasing                       Decreasing              Maintaining              Increasing         Increase
                       significantly (5%)

      Equities
 0%                      18%                         19%                                                       41%                         22%

      Fixed income
      3%
      3%                          21%                                              33%                                            36%        7%

      Cash
     2%2%              14%                                                                                            67%         9%         8%

      Absolute return funds
      3%
      3%     6%                                                                                                  71%                        3%
                                                                                                                                        17% 3%

      Real estate (unlisted)
 0%                 15%                                                                   47%                                 28%          10%

      Private equity
      3%
      3%          9%                                                               45%                                          34%          9%

      Infrastructure
 0% 3%
    3%                                                                             54%                                              37%      6%

      Direct strategic investments
 0%2%2%                                                                                                           79%                       3%
                                                                                                                                        16% 3%

      Commodities
 0%2%2%      7%                                                                                                         76%                15%

  For each asset class, do you intend on increasing/maintaining/decreasing your SAA over the next 12 months?                           Sample size: 68

12           Theme 1
Figure 1.5                                       Figure 1.6
  Allocation to alternative credit                 Preferred types of alternative credit (% citations, sovereigns)
  (average %, sovereigns)
                                                                Currently invested                Most attractive over next three years
      4.5%                                            Emerging
                                                      EM debt market debt
     2018 study
                                                                                                                    71%
                                                                                                50%
      5.3%                                            High yield corporate debt
     2020 study
                                                                                                               65%
                                                                                       41%
      6.5%                                            Real estate
                                                      Estate      debt
                                                             estate debt
     Three years’ time
                                                                                                       57%
  What is your current allocation to alternative                                         43%
  credit (as a percentage of your overall
  portfolio)? What do you expect it to be
  in three years’ time?                               Direct lending
                                 Sample size: 38
                                                                                                 51%
                                                                                   37%
Sovereigns continue to express
appetite for expanding their
                                                      Infrastructure debt
alternative fixed income allocations,
the growth of which has contributed                                                        45%
to the rising position of fixed income
                                                                   20%
within portfolios. As of the end
of 2019, alternative fixed income
                                                      ABS / Structured credit
accounted for an average of 5.3% of
portfolios. This is up from 4.5% at                                              35%
the end of 2017 and is set to rise
                                                                       24%
further to reach 6.5% over the next
three years (Figure 1.5). Emerging
                                                      Distressed debt
markets debt currently has the
widest appeal, followed by high-yield                                        31%
corporate debt and real estate debt
                                                            13%
(Figure 1.6).
                                                      Bank loans
With listed asset prices having
already regained ground and the                                             29%
global outlook still so uncertain,
                                                                17%
sovereigns emphasised that it
was in unlisted markets such as
infrastructure and real estate                     Which of the following types of alternative credit are you invested in? Which do   Sample size: 51
where many of the most significant                 you see as most attractive for future investments over the next three years?
opportunities were likely to be found.
It’s here that their size and long
investment horizons can deliver
the most significant competitive
advantage. This includes taking on
assets from other large investors
who may be forced to sell to meet
redemptions, creating opportunities
in the secondary market.
                                                                                    Fixed income’s traditional position as a defensive
                                                                                    anchor was initially tested by the crisis, with even
                                                                                    US Government debt caught up in a broad-based
                                                                                    selloff as investors rushed into cash.

                                                                        Invesco Sovereign Asset Management Study 2020                               13
Covid-19 accelerates                       Figure 1.7
existing infrastructure                    Priority areas for infrastructure investments
                                           (% citations, sovereigns)
trends and creates
distressed opportunities
Within the infrastructure asset class,
sovereigns report the highest level
of interest in electricity generation
and transmission (54%) and
communications (52%) (Figure 1.7).
Electricity projects that help countries
transition away from fossil fuels
                                                           54%                                     52%
were seen as particularly desirable
and a way of fulfilling ESG goals.
“However,” noted an EMEA-based
liability sovereign, “I don’t think
there’s a single pension fund that                    Electricity generation                     Communications
doesn’t also have this theme, so it                     and transmission
can be a challenge to source the
right investments.”

Meanwhile, communication assets
have moved up the list of targets
in tandem with the global rollout
of 5G mobile networks.

Sovereigns revealed a general
                                                           46%                                     41%
preference for infrastructure
assets that operate within highly
regulated natural monopolies, as
one EMEA-based liability sovereign                    Social infrastructure                 Oil and gas pipeline/storage
explained: “We choose based on
characteristics rather than sectors
– we like to invest in projects that
are government-run and clearly
regulated.” An APAC-based liquidity

                                                           39%                                     37%
sovereign added: “We are seeking
mature assets with stable income
and are willing to trade away some
liquidity for that.” The Covid-19
pandemic had brought many of these
qualities to the fore and several
sovereigns expressed an appetite                        Roads and bridges                        Water and waste
to look towards distressed sectors.

                                                               28%                                   24%

                                                               Railways                              Airports

                                                               17%
                                                                 Ports

                                           For infrastructure investments, in which areas                        Sample size: 46
                                           are you prioritising future allocations?

14        Theme 1
Valuations in infrastructure have
long been considered ‘full’ due to the     Figure 1.8
supply of capital chasing relatively       Priority areas for real estate investments (% citations, sovereigns)
few deals. However, sovereigns
saw the current situation as an

                                                                                      71%
opportunity to take advantage
of selling in sub-sectors that have
exposure to economic growth and                     66%
                                                                                                                        44%
could be available at attractive
valuations for the first time in
years, e.g. airports, where operators
may be looking for an injection
of capital at very favourable terms
for investors. In less affected areas,
such as toll roads, the damage to
revenues caused by the pandemic
were seen as having only a limited                    Commercial                         Industrial                       Residential
impact on cash flow projections over
the entire lifespan of a project. The      For real estate investments, in which area are you prioritising future allocations?         Sample size: 41
immediate impact on demand for
such assets, however, was seen as
much greater, particularly given the
likely prevalence of forced sellers.       Figure 1.9
                                           Deployment times (average years, sovereigns)
A similar sense of opportunism
was evident in discussions related
to real estate (Figure 1.8), with                                                                       2016             2018              2020
sovereigns expecting significant
opportunities to emerge over
the next year in areas such as                                                       3.5
                                                                                              3.2                                3.2
travel and leisure. These sectors,                                  3.0                               3.0                               2.9
at the epicentre of the current                             2.6
crisis, were seen as eventually                                                                                        2.3
returning to their previously strong                2.0
upwards trajectory in line with the
expansion of the middle classes
in emerging economies and the
rising discretionary spending on
‘experiences’ in developed economies.                 Real estate                     Infrastructure                   Private equity

With average deployment times of           How long do you think it will take to reach your                                            Sample size: 47
three years across private market          target weights in the following categories?
asset classes (Figure 1.9), the
ability to identify and transact
on these kinds of opportunistic          Sovereigns regularly highlighted                         advantage of well-resourced internal
investments is far from universal.       that the level of competition for                        teams – a topic explored in greater
Since 2018, deployment times             private market assets has been                           depth in Theme 2 – is further
have increased within real estate        increasing steadily, in line with                        amplified by the fact that direct
(from 2.6 to 3 years), while falling     average allocations among large                          investment is the preferred route into
slightly in infrastructure and private   institutional investors. Those funds                     unlisted assets, which is generally
equity. This is often attributed to      that have well-established internal                      regarded as needing considerable
real estate’s particular sensitivity     teams and can generate their own                         in-house expertise.
to market cycles and the challenge       deal flow are likely to be in the
of finding attractive opportunities      best position to act, with capacity
towards the end of the cycle, when       constraints around execution being
prices are peaking.                      a significant drag on others. The

                                                                Invesco Sovereign Asset Management Study 2020                                        15
Commodity funds brace for withdrawals
While funds are looking at the possible opportunities
arising from the current crisis, some are having to
play a significant role in helping to mitigate its impact.
A collapse in the price of many commodities, including
oil, has coincided with an increase in government
spending and a rush to announce emergency budgets
to fight the pandemic and address its economic
consequences. While public announcements of
withdrawals are rare, with the occasional notable
exception, oil-based funds may face significant outflows
over the course of the next 12 months, as government
budgets built around oil funding take a hit. “We might
well suffer severe withdrawals from the fund as a result
of the current situation – many of the criteria have
already been met,” said a development sovereign based
in Latin America.

Since the global financial crisis, most commodity-
based sovereigns have built up large cash reserves to
facilitate such requests for emergency funding, while
also making significant organisational improvements
for the management of liquidity. These include greater
recognition of liquidity objectives, more sophisticated risk
management models to understand the implications of
withdrawals for investment strategy and asset allocation,
improved reporting on liquidity metrics, and the
development of plans for how best to liquidate assets.

Because of this, most should be in a strong position
to accommodate these requests without major asset
allocation adjustments or forced asset sales. Sovereigns
noted that they would look first to cash and money
market instruments, followed by highly liquid government
securities to fund any requests. However, if the crisis
drags on and/or lower oil prices persist, funds also
acknowledged that they could be faced with a sustained
period of outflows that could see them confronted by
much harder decisions and a requirement to sell down
other assets, with passive equity allocations the next
asset class in line. Such a scenario has the potential to
lead to portfolio imbalances and would have significant
repercussions for how these sovereigns model the
assumptions underpinning both their investment
horizons and strategic asset allocations.

“We might well suffer severe withdrawals from the
fund as a result of the current situation – many of the
criteria have already been met,” said a development
sovereign based in Latin America.

16        Theme 1
Theme 2

A battle for
talent on
two fronts
Sovereigns are experiencing the                            Central banks see their
  greatest capability gaps in the                            widest capability gaps
areas of private assets, investment                        within ESG, transparency
   strategy and asset allocation.                         and fund manager selection.

                         The internalisation of investment teams,
                          driven by the need for greater control
                         rather than cost, is leading to particular
                          challenges sourcing appropriate talent,
                            particularly in emerging markets.

    These problems are being                          A significant minority still plan to engage
   addressed through a greater                        more external support, with sovereigns in
emphasis on internal development                    Asia seeking a significant number of external
    and retention, plus pooling                        mandates in equities, fixed income and
resources through co-investments                   infrastructure, and those in emerging markets
       and platform deals.                           seeking mandates across private markets.
Recruiting, retaining and              Figure 2.1
developing talent are key              Sovereign capability gaps (average rating /10, sovereigns)
priorities for sovereigns
and central banks, with                                              Importance               Capability                Capability gap
both listing it as the
most important attribute                  People and talent
for the success of their                                                                                                      8.6
organisation.                                                                                                 7.6       1.0
                                          Investment strategy/benchmarks
However, both sovereigns and                                                                                                  8.6
central banks also identified a wide                                                                    7.1             1.5
range of capability gaps and a
need to enhance and develop their         Asset allocation
human capital to address current                                                                                           8.3
shortcomings (Figures 2.1 and 2.2).
                                                                                                        7.1         1.2
                                          Risk management
                                                                                                                           8.2
                                                                                                            7.2     1.0
                                          Transparency
                                                                                                                          8.1
                                                                                                            7.2    0.9
                                          Investment reporting
                                                                                                                          8.1
                                                                                                            7.2    0.9
                                          Governance
                                                                                                                          8.1
                                                                                                            7.3 0.8
                                          Operational capability
                                                                                                                    7.6
                                                                                                      6.9 0.7
                                          Fund manager selection / due diligence
                                                                                                                    7.5
                                                                                                     6.8 0.7
                                          Internal PE / infra / real estate expertise
                                                                                                                    7.5
                                                                                              6.0            1.5
                                          Internal asset management
                                                                                                                  7.1
                                                                                                    6.6           0.5
                                                 Asset consultants
                                          Use of asset Consultantsand
                                                                   andadvisers
                                                                       Advisers
                                                                                                              6.9
                                                                                                6.2 0.7
                                          ESG
                                                                                                             6.8
                                                                                             5.9     0.9

                                       Please assess the following on a score of 1-10 (where                                    Sample size: 58
                                       10 = very important) based on A) Importance to your
                                       organisation B) Capability in these area (where 10 = very capable)

20        Theme 2
Figure 2.2
Central bank capability gaps (average rating /10, central banks)

                              Importance               Capability                Capability gap

   People and talent
                                                                                        8.6
                                                                      7.5        1.1
   Risk management
                                                                                        8.5
                                                                      7.5        1.0
   Investment strategy/benchmarks
                                                                                       8.4
                                                                  7.1        1.3
   Governance
                                                                                  8.0
                                                                     7.3 0.7
   Transparency
                                                                                  7.9
                                                            6.5            1.4
   Asset allocation
                                                                                  7.9
                                                                  7.1 0.8
   Internal asset management
                                                                                  7.9
                                                              6.8          1.1
   Investment reporting
                                                                            7.5
                                                                6.9         0.6
   Operational capability
                                                                            7.4
                                                          6.3         1.1
   Fund manager selection / due diligence
                                                                           7.2
                                                     5.8             1.4
   ESG
                                                                      6.8
                                              5.1             1.7
   Internal PE / infra / real estate expertise
                                                                6.3
                                              5.1         1.2
   Use of asset
          Asset consultants
                Consultantsand
                            andadvisers
                                Advisers
                                                                6.2
                                                    5.7         0.5

Please assess the following on a score of 1-10 (where
                                                                                        Sample size: 33
10 = very important) based on A) Importance to your
organisation B) Capability in these area (where 10 = very capable)

                                                                             Invesco Sovereign Asset Management Study 2020   21
Narrowing these gaps is challenging. Finding and keeping                        In this year’s interviews, investors often pointed to the
talent is a universal problem, one not limited to sovereigns                    cost of assembling high-quality teams, especially in
and central banks: other large asset owners pursuing                            new capability areas where they have a limited track
internalisation objectives face similar issues. For official                    record. This often means higher compensation than the
institutions, this problem is particularly noticeable in                        institution is accustomed to, requiring formal approval,
emerging markets, where high turnover and small talent                          which can cause delays or be unsuccessful entirely.
pools hinder recruitment and retention. However, even
outside of emerging markets, similar challenges often
persist, with sourcing suitable talent in the local market,
as well as attracting the best talent from abroad, being
commonly cited obstacles, along with competing with
private sector wages (Figure 2.3).

  Figure 2.3
  Key people and talent challenges (% citations)

                                                                      West          Middle East       Asia        Emerging markets

                                                                      High turnover

                                         %
                                       80
                                              %
                                            70
                                                  %
                                                60

                                                                                                                          Pr
                                                                                                                            iva
                                                                                                                               te
                                                       %
                                                     50
                ne

                                                                                                                                  sec
              No

                                                                                                                                     tor
                                                            %
                                                          40

                                                                                                                                     wag
                                                                                                                                        es
                                                                %
                                                              30
                                                                       %
                                                                     20
                                                                            %
                                                                          10
                                                                                                                                           n i t i es
     Attra

                                                                                                                                       o r tu
      ct ta

                                                                                                                                     opp
        le n
             t fr

                                                                                                                                   e nt
                 om

                                                                                                                                pm
                                                                                                                                lo
                 ou

                                                                                                                             ve
                  ts i

                                                                                                                           de
                      de

                                                                                                                          ng
                       m

                           ke
                                                                                                                      di
                         ar

                                                                                                                      o
                                                                                                                    vi

                              t   s                                                                                 Pr

                                                           Fin din                           t
                                                                     g talent in local marke

  Which aspects of people and development do you find most challenging?                                                         Sample size: 92

22              Theme 2
Capability gaps reflect battle
for talent on two fronts

A battle for talent has broken out in
areas of high demand, such as private
markets and investment strategy,
where sovereigns have the biggest
‘capability gaps’ (Figure 2.1). “The
main challenge is to build up our
private market expertise outside of
our domestic market,” explained
a North America-based liability
sovereign. “The competition for talent
is very heavy and we do not always
have the brand, so it takes some time
to develop and weighs on resources.”

ESG is another area where demand
outstrips supply, with central banks
particularly noting a discrepancy
(Figure 2.2). While the overall
importance assigned to ESG within
central banks is lower than some
other areas, the size of the capability
gap reflects the speed at which
banks are having to adopt ESG
considerations, with importance only
likely to grow as stakeholders place
increasing demands on central banks
to be setting an example in respect of
their ESG credentials.

Central banks also recognise asset
manager selection as a significant
capability gap, reflecting a drive into
new asset classes, commonly via
external mandates. Compared with
sovereigns, central banks are often
outsourcing these investments for the
first time and must close the capability
gap in their selection and monitoring
process. “Our hiring is motivated by
the use of new asset classes, including
emerging markets debt, covered bonds
and mortgage backed securities,”
said one EMEA-based central bank
respondent. “We are making use of
external managers but also want to
build up our internal expertise.”

                                           Invesco Sovereign Asset Management Study 2020   23
From acquisition                        Figure 2.4
to development:                         Policies to address people and talent challenges (% citations)
keeping the talent
                                                                                                  Central banks   Sovereigns
These challenges have spurred
a focus on policies to improve             Graduate programmes
existing talent. Some 92% of central
banks and 71% of sovereigns have                                             41%
implemented internal development                                       35%
programmes, while the majority of
both have also focused on giving           International recruitment
employees greater responsibility
(Figure 2.4). Respondents identified                                           43%
the need to do more to retain skilled                                      39%
employees targeted by the private
sector. “There is a point mid-career       Internal development programmes
where many people leave – we are
trying to address this by giving                                                                                  92%
employees more responsibility,”
                                                                                                         71%
noted one Latin America-based
central bank.
                                           Cross training
                                                                                     49%
                                                                   31%

                                           Referral programmes
                                                          22%
                                                    16%

                                           Incentives
                                                                             41%
                                                                                     49%

                                           Rotation programmes to other offices
                                                                       35%
                                                                       35%

                                           Secondments to asset manager
                                                                  30%
                                                                     33%

                                           Giving employees greater responsibility
                                                                                                     65%
                                                                                           55%

                                        Which, if any, of the following policies has your organisation              Sample size: 88
                                        introduced to overcome your challenges?

“There is a point mid-career where
many people leave – we are trying
to address this by giving employees
more responsibility,” noted one
Latin America-based central bank.

24        Theme 2
Increasing the talent pool is
Figure 2.5                                                                                          another avenue for improving
Adoption of diversity and inclusion plans (% citations)                                             internal capability. About half of
                                                                                                    respondents operate diversity
                                                                                                    and inclusion (D&I) programmes,
             No, and do not intend to consider                   No, but considering                hoping that a more diverse and
             No, but have considered                             Yes, already have this             inclusive workplace will deliver
                                                                                                    better performance (Figures 2.5
                                                                                                    and 2.6). Typical of this trend, one
          29%                        29%                  35%                  36%                  APAC sovereign said they had spent
                                                                                                    a considerable amount of time on
                                                                                                    this area, as “a more diverse talent
                                                                                                    pool will optimise the organisation
                                                                                                    to achieve our objectives. It’s a start,
                                                                                                    and we’re realistic about what’s
          15%                        14%                                                            achievable and on what timeline.
                                                          5%
                                                           5%                  19%                  Making changes will take some time
                                                          15%                                       but we’re committed.”
          12%                        7%
                                     50%                                               0%           It was also noted that some policies
          44%                                             45%                  45%
                                                                                                    in this area, such as those requiring
                                                                                                    a preference for recruiting local
                                                                                                    nationals, could make the challenge
                                                                                                    of finding the right talent even
                                                                                                    harder. For example, funds may have
                                                                                                    a mandate to hire from the local
                                                                                                    population as part of their role in
                                                                                                    building knowledge and expertise in
         West                   Middle East               Asia              Emerging
                                                                               0%                   local markets. However, in markets
                                                                             markets                where talent is in short supply these
                                                                                                    employees are often then recruited
Do you have objectives around diversity and                                    Sample size: 97
                                                                                                    by the private sector or other
inclusion initiatives within your organisation?                                                     government agencies, exacerbating
                                                                                                    the challenges related to retention.

Figure 2.6
Motivation for D&I initiatives (% citations, D&I respondents)

                                                              Desire to better reflect           Anticipated better        Regulation
                                                              local population                   performance

                                                                                         100%                    100%
         85%                                      89%                           89%
                  74%                                                                            78%
                                                        67%                                                                    71%
                                                               56%
                                                                                                                        43%

                           22%

                 West                              Middle East                           Asia                         Emerging
                                                                                                                       markets

What is the motivation for your D&I framework?                                                                                Sample size: 52

                                                                        Invesco Sovereign Asset Management Study 2020                       25
Figure 2.7
  Have internalised investments over past
  three years (% citations, sovereigns)

          No, and not considering
          No, but considering
          Yes

                                                    35%

             50%

                                                                 Figure 2.8
                                                                 Proportion of asset class managed
                                         15%                     internally (average %, sovereigns)

                                                                                              2015 study      2020 study
  Have you internalised any investment         Sample size: 60
  during the past three years?

                                                                    Equities
                                                                                    34%
Internalisation drives demand for                                                                54%
talent among sovereigns
                                                                    Fixed income
The internalisation of investment capability was regularly                                         57%
cited by sovereigns as a reason for the recruitment and                                             58%
retention of talented teams becoming even more crucial.
Half have invested in internal investment capability                Private equity
over the past three years (Figure 2.7), with a focus on
equities, private equity and infrastructure (Figure 2.8).                       28%
                                                                                               50%

                                                                    Real estate
                                                                                         42%
                                                                                         42%

                                                                    Infrastructure
                                                                        16%
                                                                                         41%

                                                                 What proportion of the following asset    Sample size: 2015 = 33
                                                                 classes do you manage internally?                      2020 = 36

26          Theme 2
Equities is often the second asset
Figure 2.9                                                                                       class internalised (after fixed
Main benefits of internalisation (% citations, sovereigns)                                       income) and more than 50% of
                                                                                                 equity allocations are now managed
                                                                                                 internally, up from 34% in our 2015
                                                                                                 study. The reasons for this vary by
                                                                                                 organisation, but one commonly
                                                                                                 cited factor was the dominant role
                                                                                                 of beta in driving returns since

                58%
                                                                                                 the global financial crisis, which is
                                                                                                 often seen as being more efficiently
                                                                                                 targeted via internal teams due to

                                                                 33%                             the relative simplicity of tracking
                                                                                                 market indices.

                                                                                                 Internalisation has also happened
                                                                                                 rapidly in private equity (up to
        Control over investments                       Generate better performance               50% from 28% in 2015) and
                                                                                                 infrastructure (up to 41% from 16%).
                                                                                                 The size of these changes should be
                                                                                                 treated with some caution due to a
                                                                                                 degree of movement in the sovereign

                31%
                                                                                                 sample between the 2015 and 2020
                                                                                                 studies. That said, it’s an accurate
                                                                   22%                           reflection of the direction of travel,
                                                                                                 with sovereigns seeing benefits in
                                                                                                 terms of both access and deal flow
       Lower management costs                                    Manage risk                     from bringing these asset classes
                                                                                                 in-house and the creation of satellite
                                                                                                 offices in important local markets
                                                                                                 where many deals take place. In
                                                                                                 contrast, there has been limited
                    19%                                            17%                           further internalisation within fixed
                                                                                                 income, which can be part-explained
                                                                                                 by rising allocations to alternative
         Access to opportunities                        Maximise economies of scale              credit that are often managed via
                                                                                                 specialist external managers.

                                                                                                 Control rather than cost is the
                                                                                                 driving force behind sovereigns’
                          11%                                         6%                         internalisation, as the increasing
                Alignment of                                       Employee                      need to tailor portfolios to reflect
                time horizons                                development/retention               specific objectives and philosophies
                                                                                                 is seen as harder to achieve via
                                                                                                 external mandates (Figure 2.9).
                                                                                                 “For us it is becoming increasingly
                        3%                                                                       important to know exactly what we
                                                                                                 own and to be able to stand up and
           Develop benchmark                                                                     explain why,” said an EMEA-based
          for external managers                                                                  liability sovereign.

If yes/considering: what do you believe to be the main                         Sample size: 36
benefits of the internalising asset management capability?

                                                                        Invesco Sovereign Asset Management Study 2020               27
Internalisation has stoked a battle
for talent, and 37% of sovereigns       Figure 2.10
that have internalised investment       Change in expense ratio in past three years (% citations, sovereigns)
capability over the past three years
have seen their expense ratio
increase, while only 22% have seen                      37%                               29%                Moderately increased
costs come down (Figure 2.10).                                                                               (
Increased use of external               Figure 2.12
management still on the                 Plans for externalisation vs internalisation over
                                        next three years (% citations, sovereigns)
agenda for many

Despite a well-established trend                More externalisation                  No change               More internalisation
towards internalisation over the
past five years, sovereign plans for
the next three reveal this masks           Equities
a more complex picture, with a
significant minority planning to           Total 8%                                                  58%                         34%
engage more external management            West3%3%                                                       69%                    28%
across all asset classes (Figure
2.12). This includes sovereigns              0%
                                             ME                                              57%                                 43%
reversing previous moves towards                                 25%                              37%                            38%
                                            Asia
internalisation, with some noting
that the anticipated benefits had            EM            17%                         33%                                       50%
been harder to realise than expected,
leaving them unable to justify an
increase in associated costs.              Fixed income

There are also notable regional            Total 10%                                                                 74%         16%
variations. Over the next three
years Asian organisations are              West 7%                                                                  76%          17%
most likely to be seeking external           0%
                                             ME                                                           71%                    29%
expertise in equities, fixed income
and infrastructure, while in the             0%
                                            Asia                     29%                                                         71%
West there is only limited movement                        17%                                                      66%          17%
                                             EM
in either direction (Figure 2.12).
In the Middle East, there is still
expected to be a strong trend              Real estate
towards internalisation for equities,
fixed income and real estate.              Total       13%                                                 60%                   27%
However, a significant minority are
looking for external managers to           West 10%                                                                 73%          17%
play a greater role in infrastructure
                                             0%
                                             ME            17%                                                                   83%
and private equity. Meanwhile, in
emerging markets, where many                Asia           17%                                        50%                        33%
sovereigns are more recently
established and have more limited            0%
                                             EM                                        50%                                       50%
internal resources, there is a move
towards internalisation for equities
but a trend towards externalisation        Infrastructure
for private markets assets such as
real estate and private equity.            Total         15%                                                     65%             20%
                                           West 7%                                                                     79%       14%
                                             ME                      29%         14%                                             57%
                                            Asia                                       50%                          33%          17%
                                             0%
                                             EM                                                                                  100%

                                           Private equity

                                           Total        14%                                                                74%   12%
                                           West          15%                                                                77% 8%
                                             ME            17%                                        50%                        33%
                                             0%
                                            Asia                                                                    83%          17%
                                             0%
                                             EM              20%                                                                 80%

                                        Over the next three years how do you expect this to change for each asset class?     Sample size: 50

                                                            Invesco Sovereign Asset Management Study 2020                                  29
Sharing the burden                          Figure 2.13
through co-investments                      Preferred structure for unlisted investments
                                            (% citations, sovereigns)
and platform deals

Even when sovereigns have built a                     Investment
                                               Direct investment
strong internal team, many admit                                                                 64%
that the complexity of executing on
multiple private market deals can put          Co-investment
                                               Co-Investment
a significant burden on those teams.
They are often small, due in part to                                    34%
the challenges of finding the right
talent. This can put a limitation on                    Account
                                               Separate account
the number of investments, as any                     14%
deal must be of sufficient scale to
merit devoting internal resources.                         Strategies
                                               Replication strategies
An EMEA-based liability sovereign
elaborated: “The investment team                  8%
is maybe 25 and the illiquid team is
four. We really have to be selective in               Fund// Pooled
                                               Mutual fund   pooled Vehicle
                                                                    vehicles
terms of investment opportunities. In            7%
our ‘impact’ team we see some very
exciting opportunities, but many are
too small to invest in.”                    For you unlisted investments, do you                                      Sample size: 59
                                            have a preference for structure?
Co-investments are considered
an attractive way of sharing
resources and reducing this burden        you more of a direct benefit, allowing              Similar sentiments were common
(Figure 2.13). Sovereigns pointed         you to leverage the insights of the                 among medium-sized sovereigns,
to the compounding benefits of            partners you work with,” explained                  who need to be making large
doing co-investments, with the            an APAC-based liability sovereign.                  enough deals to make a dent in
first deals often tricky due to                                                               their allocation targets but who
differences in organisational culture     Investors are looking at other ways                 often struggle to get invited to
and established procedures. Over          to gain more control over their                     the top table of sovereigns doing
time, however, this led to a powerful     unlisted investments without putting                the largest co-investments. These
network of collaborators, with            an unacceptable burden on internal                  approaches offer sovereigns
many working with a small group           teams. We found appetite among                      some of the advantages that are
of partners across multiple deals.        sovereigns for pooled platform deals                otherwise only available to those
                                          that give them a say over the assets                that have recognised a capability
Respondents noted that because            being targeted but with less need for               gap and have made the investment
each sovereign may have specialised       direct involvement in each deal. This               required to identify, recruit and
expertise in particular industries        was articulated by a Europe-based                   retain the talent to deliver.
and geographies, such a network           liability sovereign: “Traditionally we
was very effective at creating            invest via fund of funds but these
deal flow and access to attractive        are less appealing due to the fee
opportunities. “We prefer to go in        structures and lack of control. We
through our own teams to have             are looking to do more via platform
more control but sometimes we don’t       deals set up to target investments
have expertise, so gain access via a      in infrastructure across themes
mandate. Co-investments also give         that we like.”

                                                                                   “We prefer to go in through our own teams
                                                                                   to have more control but sometimes we don’t
                                                                                   have expertise, so gain access via a mandate.
                                                                                   Co-investments also give you more of a direct
                                                                                   benefit, allowing you to leverage the insights
                                                                                   of the partners you work with,” explains an
                                                                                   APAC-based liability sovereign.

30        Theme 2
Invesco Sovereign Asset Management Study 2020   31
Theme 3

Gold: a glimmer
of hope amid
market turmoil
80%
                                                                             central banks
                                                                increasing allocations from
                                                                    existing USD assets

 Ongoing market turmoil has seen                        80% of central banks choosing to increase
a continuation of gold’s popularity,                 gold allocations are doing so from existing US$
with allocations rising as Covid-19                  assets, as central banks look to diversify away
  reveals an asset class that may                      from the dollar without sacrificing liquidity
 be staking a claim for a new role                     and convertibility. This trend was especially
   within institutional portfolios.                    prominent among emerging market banks.

                            Central banks are particularly attracted
                            by gold’s potential as a replacement for
                           negative-yielding debt, its low correlation
                          to other central bank assets, and liquidity.

                                                                         40%        sovereign
                                                                                    investors

                                                           gold futures           gold-backed
                                                                                     ETFs
  Risk on                  Risk off

  For sovereigns, gold is seen as a                       While central banks are predominantly
  potential inflation and tail hedge                   investing in physical gold, 40% of sovereign
   for the portfolio, with positive                       investors are investing via futures and
  correlations in risk-on scenarios,                       gold ETFs, principally due to the ease
 but barely correlated / negatively                         of trading, an approach potentially
correlated during a risk-off scenario.                       attractive to some central banks.
This year’s study sees                                  Figure 3.1
      significant interest in                                 Planned change in gold allocations
                                                              over next 12 months (% citations)
      gold from both central
      banks and sovereigns: an
      interesting development,                                                                                  Increase         Same          Decrease
      given that gold was typically
      viewed as a traditional                                               18%                               18%                          23%
      central bank asset dating
      back to the gold standard.                                            79%                               78%
                                                                                                                                           77%

      This is a continuation of the trend
      we identified last year, where a
      number of central banks had either
      increased their gold allocations
      or were looking to do so over the                                      3%                                4%                           0%
      coming year: specifically, roughly
      a fifth were considering increasing                             2019 Study                         2020 Study                 2020
                                                                                                                                     2020Study
                                                                                                                                           StudyB
      allocations (Figure 3.1). However,                            (central banks)                    (central banks)               (sovereigns)
      last year storage costs were cited
      as an obstacle, especially given the                    How are these allocations likely to change over the                       Sample size: 2019 = 34
      preference by some central banks                        coming year? Do you envisage making changes to                                         2020 = 58
                                                              your gold allocation in the next 12 months?
      to store gold in their own vaults.

      Investors expect the trend towards                   scrambled for cash in March, gold
      increasing allocations to continue                   was a popular source of liquidity,
      in 2020 – despite high prices – as                   resulting in a short-lived dip in price
      Covid-19 reveals an asset class                      yet recovering quickly to previous
      that might well be staking a claim                   levels within just a couple of weeks.
      for a new role within sovereign and                  Importantly, the market had remained
      central bank portfolios. As investors                relatively liquid (Figure 3.2).

        Figure 3.2
        Gold price (USD)

                                                                                                           Daily price          12m trailing average

           1,800

           1,600

           1,400

140        160
           1,200

           1,000
                  2015                      2016                     2017                       2018                     2019                   2020

        Gold Price: London Price and NY Futures (Price, Rebased) as at 31st May 2020.

      34          Theme 3
Central banks: uncertain                   Figure 3.3
times reflect well on a                    Average allocation to gold (average %, central banks)
traditional reserve asset
                                                                                                                            4.8%
Average allocations to gold                                                                    4.5%
increased very slightly through                                           4.2%                               4.2%
2019, consistent with the intention                   3.5%
expressed by some managers in
last year’s survey (Figure 3.3).
Furthermore, a similar proportion
(18%) expect to continue increasing
allocations, meaning that allocations
are likely to continue rising, at least
over the longer term.
                                                      2016               2017                  2018         2019            2020
80% of central banks choosing
to increase allocations are doing          For the total reserves portfolio, please indicate                                 Sample size: 36
so from existing USD assets –              the % allocation across asset classes.
significantly more than those from
(negatively yielding) EUR or GBP
allocations (Figure 3.4). This is an
important point, because it highlights     Figure 3.4
the dilemma faced by a number of           Sources of funding for banks increasing allocation to gold
central banks: how to diversify away       (% citations, central banks)
from the USD without sacrificing
liquidity and convertibility – for many,
gold has been a convenient solution.
This trend was especially prominent
among EM central banks, where
almost 90% were drawing on USD
allocations to add to gold reserves.

                                                                                                                 80%
                                                                                                                      USD

                                                                                        50%
                                                                                           GBP

                                                                                        50%
                                                                                           EUR

                                           [Central banks increasing only] Which currency would fund this increase?          Sample size: 10

                                                                 Invesco Sovereign Asset Management Study 2020                             35
While it is unlikely that gold will
replace debt as the principal             Figure 3.5
component of a reserves portfolio,        Rating of gold as an alternative to fixed income
managers do not dismiss its role          (average rating /10, gold investors)
out of hand. They rate the potential
of the asset class as an alternative
to fixed income at 5.22 on average
(out of 10) – the equivalent figure

                                                                                                             5.22
for sovereigns was 4.17 (Figure
3.5). Banks are particularly attracted
by gold’s potential as a replacement
for negative yielding debt (48%),
and diversification due to its low
                                                           4.17
correlations to other central bank
assets (44%). A large and robust
market structure and high trading
volumes give confidence in ongoing
liquidity (Figures 3.6 and 3.7).                             Sovereigns                                     Central banks

A high proportion of central banks        To what extent do you see gold as an alternative to fixed income investments?     Sample size: 48
maintain a gold allocation stored
in their own vaults, which is rarely
traded due to organisational and
political difficulties (as observed       Figure 3.6
last year, gold is frequently             Attractions of gold (% citations, gold investors
difficult to sell without incurring       increasing allocations)
some political or public attention).
In the words of one EMEA bank:
“We maintain a stable allocation as                                               Total          Central banks            Sovereigns
it is a very sensitive political issue.
If we wanted to make any changes,            Replaces negative yielding debt
it would be a very political process
within the bank.”                                                          36%
                                                                                    48%
                                              0%

                                             Reduces currency concentration in the portfolio
                                                                           36%
                                                                                 44%
                                                 11%

                                             Low correlations to other financial assets
                                                                                   47%
                                                                                 44%
                                                                                           56%

                                             High risk adjusted return
                                                                                42%
                                                                                 44%
                                                                        33%

                                             Hedge against inflation
                                                                      31%
                                                            22%
                                                                                           56%

                                          [If increase] Why is this the case?                                               Sample size: 36

36         Theme 3
Figure 3.7
  Drivers of confidence in gold’s liquidity (% citations, gold investors)

                                                                                  Total      Central banks       Sovereigns

                          73%                                             73%
                                                   64%       61% 57%               61% 63%
                                                                                              55%
          46%                            50% 46%
                  37%
                                                                                                          7%   3% 18%

      Global non-financial                Swaps/Futures     Trading volumes       Market structure     Limited confidence
           demands                           market

  What gives you confidence in gold’s liquidity?                                                                   Sample size: 46

                                                                                 The use of gold swaps has allowed some
  Figure 3.8                                                                     central banks to deploy gold for short
  Investors using gold swaps (% citations, gold investors)                       term liquidity, as well as earning a return.
                                                                                 According to one Latin American central
                                                                                 bank: “Given our liquidity challenges, gold
                                                                                 swaps offer us an ideal way to access dollar
                                                                                 liquidity and make a return without taking on

              50%                                    58%                         excessive risk.” A significant number (58%
                                                                                 of banks, including 70% of developed market
                                                                                 banks) employ gold swaps. While returns are
                                                                                 not necessarily high, such swaps are relatively
                                                                                 liquid and offer potentially better rates than
                                                                                 some government bonds. (Figure 3.8).

                Sovereigns                           Central banks

  Have you engaged in gold deposits or swaps                   Sample size: 48
  to generate a return or for security purposes?

According to one Latin American
central bank: “Given our liquidity
challenges, gold swaps offer us an
ideal way to access dollar liquidity
and make a return without taking
on excessive risk.”

                                                                     Invesco Sovereign Asset Management Study 2020               37
Sovereigns: gold has been                                                         Figure 3.9
an attractive asset class for                                                     Investors with a strategic allocation to gold
                                                                                  (% citations, sovereigns)
generating uncorrelated returns

While central banks often approach gold with a pre-existing                                Target allocation               No target allocation
allocation, the starting position for sovereigns is rarely the
same. For many sovereigns, the decision to make allocations                                                                            15%
to gold often entails adding both investment capability and
potential complexity to a portfolio.

Some 15% of sovereigns have made a strategic allocation
to gold, and just over a fifth of these are looking to add
further to that allocation. This suggests that gold is
beginning to take on a role not only as a traditional reserve
asset, but also as an asset with a role in an institutional
portfolio (Figure 3.9).

For sovereigns, gold is a powerful inflation and tail hedge,
while also demonstrating positive correlations in risk-on                                      85%
scenarios, but is barely correlated / negatively correlated
during a risk-off scenario. It’s also a highly liquid asset, with
significant global non-financial demand (jewellery,
technology, etc.) all but guaranteeing robust future demand.
The gold price is powered by both pro and counter cyclical                        Does gold have a target allocation within the SAA?         Sample size: 55
drivers, making it a reliable store of value in times of crisis.

  Figure 3.10
  Gold trading volumes

                German Bunds
      Dow Jones (All Stocks)
         US Corporate Bonds
                         UK Gilts
                        Euro/yen
                        US T-Bills
                   Euro/sterling
                              Gold
               S&P (All stocks)
           US 1-3Y Treasuries
                                                20            40        60       80      100       120                             140            160
                                                               Trading volumes (USD Bn average / day)

  Source: https://www.gold.org/goldhub/data/trading-volumes, as at 31st December 2019.

Gold’s highly liquid nature, as measured by estimated
average daily trading volume, can be especially
attractive to sovereigns. Gold trading volumes are
estimated to be roughly equivalent to those for S&P 500
securities and approaching 1-3 year Treasuries (Figure
3.10). The global financial crisis presented examples of
ways in which gold can be a store of liquidity in a crisis.
As liquidity dried up towards the end of 2008, the Gold
Overnight Financing Rate (the rate paid forwards to
those lending gold) fell below Agency Repo, LIBOR
and GC repo rates, meaning that it was cheaper to
obtain cash via a gold swap than via the usual channels.

38          Theme 3
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